18. Suppose that the price of a Big Mac is a good approximation of the price lev

Question

18. Suppose that the price of a Big Mac is a good approximation of the price level in the country. A Big Mac costs £2 in London and $3 in New York.

a.    If purchasing power parity holds, what is the exchange rate between the U.S. dollar and the British pound to the nearest two decimal places?

______________ US Dollars per British Pound ( 5 marks)

b.    If the current exchange rate is $1.6 USD per pound, what is the dollar price of a Big Mac in London

to the nearest two decimal places?

USD $______________. (5 marks)

Explanation / Answer

18(a).

If purchasing parity holds, then

£2 in London = $3 in New York.

So, £1 = $1.5

So, we can say that if the purchasing parity holds then the exchange rate between the U.S dollar and British pound is 1.5 US dollars per British pound.

(b)

If the current exchange rate is $1.6 USD per pound, what is the dollar price of a Big Mac in London is,

£1 = $1.6

So,  £2 = ($1.6 *2) = $3.2.

So, the dollar price of a Big Mac in London is $3.2.

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